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Taxes and Appreciated Securities: When Should You Sell?

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During the month of March we’ve been discussing the subject of taxation (as part of ThinkAdvisor’s 22 Days of Tax Planning Advice: 2015). In this post, the third in my series of blogs on tax planning, we’ll look at whether we should sell or hold an investment after it has risen in value. We’ll consider the tax implications and introduce a method which can help with this decision. 

To begin, let’s assume you bought 10 shares of XYZ stock at $10 per share. Your initial investment would’ve been $100. Further assume it is a few years later and the stock has risen from $10 to $20 per share. Your $100 has now grown to $200 and you are considering selling the security. You are hesitant, however, because of the taxable liability. 

(Even though I am using small numbers, even with a few additional zeros, the methodology remains the same. It would just become a more serious decision.) 

Here’s the relevant question. Should you sell the stock or wait? If you think the stock’s price might fall, how much of a decline would compel you to sell now? 

If you sell the security at $20 per share, you would owe tax on the $100 profit. Assuming a 15% capital gains tax rate, your tax liability would be $15 ($100 x 15%). This would leave you with $185 after paying the tax ($200 – $15).

If you did not sell, how much would the stock’s price have to fall to equal the same net proceeds of $185? If the share price falls by $1.50 to $18.50, the stock position would have a value of $185 (10 shares x $18.50). The loss of $1.50 per share represents a decline of 7.50%. Therefore, if you sold at $20.00 or held the stock and it fell to $18.50 per share, you would have the same value. However, if you didn’t sell the stock, you would still have an unrealized capital gain which would be subject to tax when you ultimately sell.

The guiding principle here is to determine how much the stock price would need to decline to equal the loss incurred from paying the tax if you sold at the current price of $20. 

What if the gain was less than in the previous example? Using the same initial purchase price of $10, if the price per share rose to $15 rather than $20, and you sold and realized a $50 profit, you would have $142.50 after taxes. In this case, the stock would need to decline by 5.0% to arrive at the same value. If the stock had risen to $12.50 per share and you sold, the break-even percentage would be 3.00%.

In summary, as the unrealized gain declines the break-even percentage gets smaller.

See the latest in ThinkAdvisor’s 22 Days of Tax Planning Advice: 2015.